Back in October, we discussed the likelihood that a stock rally may be in the works as the combination of better-than-expected earnings, economic data, peak hawkishness from the Fed, extremely short-term oversold conditions and positive seasonality were all coming together at the perfect time. Turns out, we weren’t optimistic enough! Since Nov 1st, both stocks and bonds have displayed significant strength, with the S&P 500 up roughly 12%, the Barclays Bond Aggregate Index up 6.4% and the Russell 2000 (small cap stocks) up an incredible 19.5%!! You also may recall in 2022 that many strategists were declaring the “Death of the 60/40 Portfolio”. Well, that claim may have been a little premature.
The chart above from Charlie Bilello shows the Monthly Total Returns for a US only 60/40 portfolio going back to 1976. A 60% stock/40% bond allocation has historically been considered a “balanced” portfolio and is one of the most common allocations for investors. November produced a return of 7.3% for a 60/40 portfolio, which was the 9th best month since 1976 and 2nd best month in the last 30 years!! Calls for the “Death of the 60/40 portfolio” started in 2022 when both stocks and bonds fell in unison, with a maximum monthly drawdown of -7.3% during 2022. This chart serves as a good reminder that no strategy is effective 100% of the time, but discipline and process will almost always win out over the long term vs. the emotion and recency bias of the short term.
Peak Hawkishness, CPI Report, Bond Yield Declines
We mentioned in our last Market Insight that a combination of factors were setting the stage for a potential rally in stocks. One of those was “peak hawkishness” from the Fed. This is the idea that the Fed had already moved past the point where they were considering large and/or continuing rate hikes and were entering a period where taking more of a “wait and see” approach was prudent. Many believed, some still do, that we have entered a “higher for longer” era, where the Fed keeps short term rates elevated to continue the fight against persistent inflation.
Things seemed to change when the November CPI report was released. Ironically, there was nothing in the report that was surprising. Both headline and core CPI levels continued lower on a year-over-year basis and the readings were very much in line with expectations. But it was enough for the market to abruptly shift from the idea of “higher for longer” and begin to price in the possibility of rate CUTS as soon as 2024. Not only has the market priced in this new reality, the Fed seems to be softening their tone as well. Their most recent projections for rates in 2024 show 3 cuts throughout the year.
This apparent shift in rate policy not only accelerated stocks climb, but it also caused bond yields to decline, with the 10-year yield going from 5% to roughly 3.9% over the course of about 45 days. Don’t forget that when rates fall, prices rise. This drop in rates not only helped support the stock rally, but it has also generated some significant bond returns over a very short period of time. During our October webinar, we mentioned the much improved risk/return profile for bonds and even after this large drop in yields, we still think it makes sense to take advantage of elevated yield levels and lock in those attractive income levels for the foreseeable future.
Soft Landing vs. Recession
While the move lower in rates has been a welcome sign for investors, not everyone is convinced this move is warranted. There is still a chorus of strategists that believe lower yields are forecasting a growth slowdown in 2024. One that would bring a recession and, most likely, a lower stock market. The data remains mixed and the possibility of a “soft landing” isn’t completely out of the question. The “soft landing" would involve inflation coming down on it’s own while growth remains solid. This would also allow the Fed to gradually reduce rates as opposed to cutting them aggressively during a recession.
The implications for both stocks and bonds under a recession vs. soft landing scenario are certainly not the same, especially on the stock side. A recession would likely lead us to lower our exposure to stocks and increase our bond/cash holdings, while a soft landing could further the rally we are experiencing now, with some segments of the market, such as small caps and value playing catch up to the outperformers of 2023, growth and large caps.
Ultimately, the result may lie somewhere between these two extreme scenarios. Mixed economic data could contribute to an ever-changing narrative that swings from optimism one week to pessimism the next.
As we move into 2024, our focus remains on allowing the data to guide us and help determine which path we are on: recession, soft-landing or “something else”. As of now, we don’t see any imminent threat of recession, which is reflected in our continuing overweight allocation to stocks vs. bonds. We may see some selling pressure at the beginning of the year as investors who plan to defer tax obligations rebalance portfolios in the new tax year (we may be one of them). Outside of that, we are hopeful that this rally can continue into the 2024 and beyond.
Weekly Focus – Think About It
“There are two ways to be fooled. One is to believe what isn’t true; the other is to refuse to believe what is true.”
Performance last week for the four major asset classes were:
- U.S. Stocks – Russell 3000 (IWV) – Gain of 2.85%
- Developed Foreign Markets (EFA) – Gain of 1.72%
- Emerging Markets (EEM) – Gain of 2.01%
- Fixed Income (AGG) – Loss of -.19%
(Note: performance is based on the change in price plus dividends)
Last Week’s Headlines
- The Fed’s most recent “dot plot” pointed to three rate cuts in 2024 and likely took future rate cuts off the table without a change in the path of inflation
- Markets responded to the Fed meeting by continuing the rally in both stocks and bonds
- The Fed’s preferred inflation gauge, PCE Index, showed further softening of inflation
Eye on the Week Ahead
- Data will be light during the Christmas week, with Consumer Confidence and jobless claims likely in focus
If you have questions, please contact a member of HCM’s Wealth Advisory Team:
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